What is the formula for RAROC based on the given factors?

The selected answer for the RAROC formula is appropriate because it effectively factors in the key components necessary for a proper risk-adjusted return calculation. RAROC, or Risk-Adjusted Return on Capital, is a performance measurement framework that assesses the profitability of a capital allocation relative to the risks involved.

In the context of this formula, revenues represent the total income generated from operations, while expenses capture all costs incurred in producing that income. The expected loss (EL) must be deducted, as it reflects the anticipated losses due to credit risk or other factors that could diminish profitability. Including the return on equity acknowledges the cost of capital or the investors' required return, providing a clear perspective on how much value is being created beyond what is necessary to satisfy those capital costs.

The use of the term "transfer price" in the formula indicates an adjustment may be needed for accounting transactions between divisions within a company that can impact the perception of profitability. This addition, along with the subtraction and additions outlined, allows for a comprehensive reflection of financial results against the required capital, thereby delivering an accurate measure of value creation in relation to the associated risks.

The other choices do not adequately represent the necessary factors or might misrepresent the inputs resulting in a less coherent understanding of how